Presentation Thrust: Understanding different types of agreements and contracts used in the procurement of infrastructure projects.
1.0 PROJECT FINANCING
“Project financing is the financing of the development or exploitation of a right, natural resources or other assets where the bulk of the financing is to be provided by way of a debt and is to be repaid principally out of the asset being financed and its revenues”.
1.1 WHY PROJECT FINANCE
Project finance can be used for a broad range of private and public sector procurement, including infrastructure procurement.
- Infrastructure needs trillions in investment
- Corporate balance sheets are insufficient-matching of expense and financing capabilities.
- Avoids using balance sheet for financing of new projects-allows strong sponsors to develop new projects without balance sheet security.
- New entrants to the infrastructure space such as pension funds, energy funds, sovereign wealth funds.
- Provides huge capital with long maturity plus repayment structure
1.2 CONTINUUM OF PRIVATE SECTOR PARTICIPATION IN PROJECTS
Source: Author’s Construct, 2019
- Models of Project/Infrastructure Procurement:
- Engineer, Procure, Construct. (EPC)
- This model of project procurement is aimed at project where certainty of final price, and often of completion date, are extremely important such that the Employer may be willing to pay more for their project if they can be more certain that the final agreed price will not be exceeded.
- It also provides for a greater responsibility of risks on the Contractor such as cost, delay, design and performance.
- It is essentially performance oriented.
- Thus, under EPC, there is a trad- off between certainty of price and control of design.
- Joint Ventures:
JV is essentially an arrangement between two or more parties to combine or leverage their resources to achieve a common goal, usually a business object on a particular project.
Lynch (1989) defines a JV as a cooperative business activity formed by two or more separate organisations that creates an independent business entity and allocates ownership, operational responsibilities and financial risks and rewards to each member, while preserving their separate identity.
- Types of JVs
Two broad categories exists:
- Unincorporated JV:
This is loosely akin to a partnership and depending on the jurisdiction, may still have separate legal personality (in that it can contract and sue/ be sued in its own name) but not separate (limited) legal liability from members.
- Incorporated JV:
Separate corporate legal entity, with limited legal liability (liable for its own tax on profits and gains)- but generally required to provide member guarantees.
- JV Undertaking:
Where projects are tendered as JV, usually, it is required by the Employer that:
- The JV gives an undertaking that each member shall be jointly and severally liable to the Employer for the performance of the Contractor’s obligations under the contract
- Identification and authorization of the leader of the JV
- Identification of the separate scope or part of the works to be carried out by each of the JV.
- Each member of the JV is to sign the letter to the Employer for the project.
2.0 PUBLIC PRIVATE PARTNERSHIP AS A MODEL FOR INFRASTRUCTURE PROCUREMENT
Increasingly, PPP programs are being established by governments across the world as a means to deliver and maintain infrastructure, as well as to deliver other assets and services.
The principle that underlies PPP include the following:
- The need for the public sector to reduce the cost of building and maintaining infrastructure assets without negatively impacting on the quality of public sector services.
- The need to accelerate delivery of both greenfield and rehabilitation infrastructure and the expansion of brownfield infrastructure
- The ability to benefit from private sector expertise in delivering innovative technologies and services.
2.1 WHAT IS PUBLIC PRIVATE PARTNERSHIP?
While there is no single, internally accepted definition of PPP, the essentials of PPP arrangement which are encapsulated in PPP contracts are:
- A long-term contract between a Private party and a government entity (contracting authority)
- For providing a new or existing public asset or services
- Under which the Private partner bears significant risk and management responsibility
- The Private sector funds the construction of the assets during the construction period
- Public sector only pays for the asset once it has been built and made available to them.
- Where payments received by the Private partner are usually linked to performance. If the asset is not “available” or the services are not performed to the required standard, payment deductions are made.
- Asset is typically handed back to the public sector at the end of the contract.
Thus, essentially PPP is a broad form of procurement method based on public and private collaboration (across assets, finance and service) and uses finance obtained by the private sector to deliver public infrastructure and services.
2.2 PPP STAKE HOLDERS AND THEIR ROLE
|Procures the project and ultimately enters into contract with project company for construction of the asset and provision of the services.
|Special purpose vehicle, created specifically for the project, which enters into the project documents and finance documents which underpin the project.
|Enters into load agreement with project company normally lending around 70 -90% of the capital value of the project.
|Provides the initial investment in project company and usually assists with negotiation of the contracts and operation of the project.
|Special purpose holding company set up specifically to hold the shares in project company and to ring fence the Sponsor’s other assets.
|Designs and builds the assets and accepts to pass down of project company’s construction related obligations under the project agreement.
|Operates and maintains the asset once built. Accepts the pass down of project company’s O&M related obligations under the project agreement.
3.0 CONSIDERATION FOR CONTRACTING PARTIES.
- The Lender
Due to the high proportion of debt and the limited recourse available outside the PPP Project for deby repayment, third party lenders undertake rigorous due diligence upfront prior to funding to assess whether a PPP project will be bankable. The Lender needs to be confident that the Private Partner can service the debt raised to carry out the PPP project.
- Equity Investors.
Any PPP Project losses suffered by the private partner are borne first by its Shareholders, and Lenders affected only if the equity investment is lost. This means Equity investors accept a higher risk than debt providers and require a higher return on their investment. As equity is typically more expensive than debt, the aim in reducing the overall weighted average cost of capital of a PPP project is to use as high proportion of debt as possible to finance PPP projects.
- Contracting Authority
From the Contracting Authority’s perspective, the bankability of a PPP project is key to whether or not it can succeed with its ambitions to procure infrastructure through PPP. As risk allocation is so crucial to bankability, the Contracting Authority undertakes a difficult balancing act in structuring the PPP project-ensuring its bankable while resisting pressure to accept more risk than is necessary.
This is the key consideration underpinning the drafting and negotiation of PPP contract provisions.
3.1 RISK ALLOCATION
Risks associated with PPP projects are allocated to the party best able to manage or more incentivized to bear them. In assessing the likely cost impact, the parties will look at each other’s ability to bear such cost and the related impact on price, as well as whether and how the cost impact could be offset or passed on (e.g. via insurance, increasing service fee or spreading the cost across tax payers.)
Lenders will be closely involved in this analysis and the procurement process should be designed so that the Lender’s bankability issues will reflect in the bid proposals.
Most importantly, the parties should strive to achieve a balanced and reasonable risk allocation in the PPP that will provide a basis for long term partnership. This is key because in order to deliver value for money, most PPP contracts need to run for a significantly long period of time such as 15 to 30 years.
It is important to note that risk allocation is influenced by factors such as maturity of the market, the experience of the participants and the level of competition between bidders.
3.2 LAWYERS ROLE
The contractual structure is the main tool or instrument for allocating risks. It is therefore extremely essential for a lawyer acting for the Contracting Authority (for example) to understand not only how the PPP contract works, but also its relationship with the related Project Agreements and any other documents to which the Contracting Authority is a Party (such as the Lender’s Direct Agreement), or which affect its obligations and liabilities such as the Private Partner’s debt and Equity finance documents).
As regards the PPP contract itself, the interplay between the contractual provisions is so carefully balanced that they cannot be considered in isolation of each other. The PPP Contract must be looked at in its entirety.
4.0 THE PPP SPECTRUM
- A concession gives a concessionaire the long-term right to use all utility assets conferred on the concessionaire, including responsibility for operations and some investment. Asset ownership remains with the authority and the authority is typically responsible for replacement of larger assets.
- Assets revert to the authority at the end of the concession period, including assets purchased by the concessionaire.
- The concessionaire typically obtains most of the revenues directly from the consumer and so it has a direct relationship with the consumer.
- Concession covers a whole or entire infrastructure system (so may include the concessionaire taking over existing assets as well as building and operating new assets).
- The concessionaire pays a concession fee to the Authority which will usually be ring-fenced and put towards asset replacement and expansion.
- The term concession is a specific term in civil law countries. To make it confusing, in common law countries, projects that are more closely as BOT are also called concessions.
- Build operate and Transfer (BOT)
- This type of project is typically used to develop a discrete asset rather than a whole network and is generally entirely new or greenfield in nature.
- The project company generally obtains its revenues through a fee charged to the utility or gov’t rather than tariffs charged to consumers.
- Design Build Operate (DBO) Projects
- Here, the Public sector owns and finances the construction of new assets.
- The private sector designs, builds and operates the assets to meet certain agreed outputs.
- Documentations are much simpler than BOT and Concessions as there are no financing documents and will typically consist of a turn-key construction contract plus an operating contract.
- Here the operator takes no or minimal risk on the capital and will typically be paid a sum for the design-build of the plant, payable in instalments on completion of construction milestones and then an operating fee for the operating period.
- The operator is responsible for the design and the construction as well as operations and so if parts need to be replaced during the operations period prior to its assumed life span the operator is likely to be responsible for replacement.
- Management Contracts and Operation and Maintenance (O&M) Contracts.
- The awarding authority engages the contractor to manage a range of activities for a relatively short time period (2-5yrs usually).
- Management contracts tend to be task specific and input rather than output focused. Example may be the operator being paid a fixed fee by the Authority for performing specific task-The remuneration does not depend on collection of tariffs and the private operator does not typically take on the risk of asset condition.
- Operation and Management agreements may have more outputs or performance requirements.
- Where the management contracts become more performance based, they involve the operator taking on more risk, even risk of asset condition and replacement of more minor components and equipment.
- Leases and Affermage Contracts.
They differ from management contracts principally in that:
- The operator does not receive a fixed fee for his services from the awarding authority but charges an operator fee to consumers with:
- In the case of a lease a portion of the receipts going to the awarding authority as owner of the assets as a lease fee and the remainder being retained by the operator.
- In the case of affermage, the operator retaining the operator fee out of the receipts and paying an additional surcharge that is charged to customers to the awarding authority to go towards investments that the awarding authority makes or has made in the infrastructure.
- The operator tends to bear the greater operating risks and employees are seconded or transferred to the operator at operator’s cost.
- Typically, between 8 to 15 years with 4 to 5 years review
- Operator will require assurances as to tariff levels and increases over term of lease, and compensation/review mechanism if tariff levels do not meet projections.
- Operator to maintain asset register and operation and maintenance manuals/records.
- Typical to include minimum maintenance or replacement provisions towards the end of the contract, so that facilities are handed back in an operational state.
As highlighted at the outset, understanding the whole context of a PPP Project is critical for Contracting Authorities when devising and negotiating the terms of a PPP contract.
Risk Allocation has a direct impact on bankability and pricing which determines whether a PPP Project will be affordable for a Contracting Authority or users and financeable by a Private Partner- and ultimately whether the asset and or service will be provided at all by means of a PPP.
There is no one size fits all PPP Contract and contractual provisions cannot be looked at in isolation due to their close interplay.
Rob Morson Infrastructure Procurement, Construction law seminar presentations, 2019, Accra.
World Bank Group, Guidance on PPP Contractual Provisions, 2017 edition Global Infrastructure Facility
Will Hughes et al Construction Contracts, Law and Management, 5th Ed. 2015